Weekly Recap & Outlook – 5/08/09

 Tower Private Advisors

Capital Markets Recap

May 8, 2009


  • Modest format change
  • Stress?  What stress?
  • Economists underestimating across the board

To allow a bit more time for some actual insight into the market’s action, I’ve decided to present the change update in a table format, as you’ll notice above. 

   Current   Last Week  $ Chg % Chg
S&P 500        926.76        877.52 49.24 5.61%
DJ Industrial Average      8,552.58      8,212.41 340.17 4.14%
S&P Mid Cap 400        584.25        558.87 25.38 4.54%
Russell 2000      1,225.07      1,210.26 14.81 1.22%
NASDAQ Composite Index      1,734.55      1,719.20 15.35 0.89%
Dow Jones World & Region – World x U.S.        158.82        146.75 12.07 8.22%

In the interest of full disclosure, we are looking for a correction in stocks, albeit a modest one.  If that colors this commentary, well, you at least know where it’s coming from.  Here are a few concerns:

  • Insider activity is downright bad.  See the recent detailed post on why that should concern you by clicking here
  • The rally since March 6 has been concentrated in low quality stocks.  That is, the companies with the highest debt ratios, lowest return-on-equity, worst revenue growth, and worst earnings growth have performed the best.  We bought some of these junky companies ourselves in that time period, but at some point the high-quality companies should begin to catch up.  This exact same phenomenon occurred in 2003 at the beginning of the run to 2007, so it, alone, shouldn’t cause one to panic.
  • Markets have a tendency to change directions within a day or two of Non-Farm Payrolls day.
  • Dumb money investors are starting to embrace the rally.
  • The Dow Transports are not yet confirming today’s high in the Dow Industrials.  That’s non-confirmation for Dow Theorists and needs to be watched.

To be fair, there is still about 45% of the equity market’s capitalization sitting in money market funds, and that could mean a lot more fuel for the rally.  Stocks are still selling at relative bargains, and there is still plenty of disbelief amongst investors.

   Current   Last Week  $ Chg % Chg
10-year Treasury            3.29            3.17 0.12 3.85%
30-year Treasury Bond            4.29            4.11 0.17 4.16%

The authorities don’t seem terribly concerned about stopping the rise in interest rates.  That could prove to be troublesome for stocks on a number of levels, not the least of which is that, with increasingly higher yields bonds become marginally more attractive.


As you can see in the table above, natural gas has been on a tear.  Odd, isn’t it, the winter heating season is over, the summer cooling season isn’t here, and natural gas is rallying.  As to why it’s up and moving further upward is beyond me.  The commodity pits aren’t helpful; no one group is or was noticeably long or short of the gas.  It’s rally, though, is bound to be short lived.  The bounce appears to be just a reaction for now.

   Current   Last Week  $ Chg % Chg
Light Crude Oil – Continuous Contract          56.71          53.20 3.51 6.60%
Natural Gas – Continuous Contract            4.08            3.55 0.54 15.09%
Gold – Continuous Contract        915.50        888.20 27.30 3.07%
United States Dollar Index          82.58          84.71 -2.13 -2.51%



Meanwhile, the dollar is getting the complete stuffing beaten out of it, but with its sharp run at the 200-day moving average, it’s due for a breather.  I can’t confirm this but trust the source that the dollar fell against all major currencies today.  As you know, there’s really no way to definitively say that the dollar has strengthened or weakened.  It usually strengthens against a few currencies even while it weakens against many more.  In addition to the current wave of happiness sweeping Wall Street, the falling dollar has been a huge and unmentioned source of strength for stocks, boosting not just the commodity stocks, but all stocks.  This will be somewhat self-reinforcing, too, as it suggests an increased appetite for risk.  That it’s not yet inflationarycan be seen in the relative underperformance of gold bullion.

Top Stories

Ostensibly, the biggest story of the week was the release of the results of the much-ballyhooed government Stress Tests of the nation’s 19 largest banks.  I say “ostensibly” because it wasn’t a story, it was many stories leaked out over the course of week, after the entire batch of results were delayed from last week.  In my humble opinion, this whole thing is a complete and utter sham.  First, the means of floating the results to the media via supposed leaks just seems hokey–little trial balloons to test the market’s appetite for the news.  They should have known we’re in the usual market-participant twilight zone, that time after the market’s rallied for a while and a dearth of bad news gets transformed–somehow–into good news. 

Second, and more egregious, is the test itself.  Nothing this serious gets produced by the government and its minions without a clever acronym.  This time the Federal Reserve went with SCAP, as in Supervisory Capital Assessment Program.  Here’s an excerpt from the Fed’s April 24 release of the Design and Implementation document:

The [Banks] were asked to estimate their potential losses on loans, securities, and trading positions, as well as pre-provision net revenue (PPNR) and the resources available from the allowance for loan and lease losses (ALLL) under two alternative macroeconomic scenarios. Each participating firm was instructed to project potential losses on its loan, investment, and trading securities portfolios, including off-balance sheet commitments and contingent liabilities and exposures over the two-year horizon beginning with year-end 2008 financial statement data. Firms were provided with a common set of indicative loss rate ranges for specific loan categories under conditions of the baseline and the more adverse economic scenarios. Firms were allowed to diverge from the indicative loss rates where they could provide evidence that their estimated loss rates were appropriate. In addition, firms with trading assets of $100 billion or more were asked to estimate potential trading-related market and counter-party credit losses under a market stress scenario provided by the supervisors, based on market shocks that occurred in the second half of 2008.

Seems reasonable, doesn’t it.  Sure, until one considers the what is meant by “more adverse economic scenario.”  Two pages later that’s revealed. 

 By design, the path of the U.S. economy in this alternative more adverse scenario reflects a deeper and longer recession than in the baseline. However, the more adverse alternative is not, and is not intended to be a “worst case” scenario. To be most useful, stress tests should reflect conditions that are severe but plausible.


Fair enough, right?  Severe but plausible.  So, what’s severe?  Well, the so-called Baseline forecast is for a 2009 unemployment rate of 8.4%; for scenario 2, 8.9%.  In 2010, the Baseline unemployment rate is 8.8%; more adverse, 10.3%.  10%!  You’ll see below that we’re up to 8.9% after this Friday’s Non-Farm Payrolls report.  According to the well-respected Liscio Report “On the Economy,” this is not your garden-variety (whatever that means) recession.  It’s one that’s “synchronized” (read, global in scope) and derived from financial excesses; that’s very bad.  From their assessment of history, based on where the U.S. economy is presently, we’re only halfway to the average GDP loss, and with comparisons to the 1930s abounding there’s plenty of reason to think this iteration will be worse than average.  You have the opportunity, below, to cast your vote on what you might have used as your version of the not-intended-to-be-a-worst-case

What’s more the, “more adverse” scenario . . .

Was contructed from the historical track record of private forecasters as well as their current assessments of uncertainty.  In particular, based on the historical accuracy of Blue Chip forecasts made since the 1970s, the likelihood that the average unemployment rate in 201 could be at least as high as in the alternative more adverse scenario is roughly 10 percent. 


Already the Blue Chip forecast for 2009 of 8.3% unemployment has been blown away, and let us keep in mind that it is this same herd that saw the sub-prime mortgage problem as “contained” earlier, and now we’re supposed to believe that their “more adverse” case, which is mere spitting distance away, represents a stress test.  As the Liscio Report suggests, “it looks like Washington’s aim is to restore confidence in the financial system before restoring the financial system to health.” Oh, and aren’t there a few more banks out there?

Anyway, if you care, here are the results of the stress test, so-called.


Extra capital required

Tarp funds  received

Total assets

JPMorgan Chase




Goldman Sachs








US Bancorp




Bank of New York Mellon




State Street




Capital One








American Express




PNC Financial




Fifth Third




Morgan Stanley












Regions Financial












Wells Fargo




Bank of America




This Week

This wasn’t such a good week for economists.  They did a lousy job of forecasting just about every economic release of this week.  Here’s just a sampling of the errors.

  • Pending Home Sales:  forecasted 0%; actual +3.2%
  • ISM Non-Manufacturing:  forecasted 42.2; actual 43.7
  • ADP Employment Change:  -645,000; actual -491,000
  • Initial Jobless Claims:  635,000; actual 601,000

Let us just focus our attention on employment data from this week.  First, Initial Jobless Claimsrose less than expected (601,000 vs. 635,000), although the prior week’s results were revised modestly upward (from 631,000 to 635,000).  The first result was positive, the second negative.  The whole notion of Bernanke’s “green shoots” in the economy is being over-hyped to an extreme.  While the drop in claims is a positive, we need to see downward revisions to past data.  Jobless ClaimsContinuing Claims–those still on the benefits roll–continued to move higher, from 6.295 million (revised upward from 6.271 million) to 6.351 million.

Next up was today’s all-important Non-Farm Payrolls (NFP) report.  Whereas economists looked for losses of 600,000, the actual losses were considerably less at 539,000.  Unfortunately, March data was revised higher by 5.43%, from 663,000 to 699,000.  That pushed the revised data to the second worst reading of this recession, behind January’s -741,000 blowout.  Manufacturing Payrolls saw similar results.  Economists looked for losses of -155,000; actual losses were -149,000.  March losses were revised upward by 3.7%, from -161,000 to -167,000.  Derived from the separate, Household Survey, the Unemployment Rate moved up from 8.5% to 8.9%. 

So far, the trend of fewer cuts (falling jobless claims, lower NFP) + no hiring (continuing claims moving higher) continues, and as it continues the unemployment rate is likely to move higher.  As has been mentioned here ad nauseum, employment is a lagging indicator and will move higher after the recession’s end.  That brings up a real risk related to the bank stress tests:  the worst case scenario for the unemployment rate was 10%, only a bit more than the current level.  Who, among the six readers of this blog, wouldn’t project a badder worst case unemployment level?  Time for a survey.

Next Week

Tuesday - monthly Trade Balance figures are expected.  These figures have become increasingly importance as it was our tremendous trade deficit that forces foreigners to recycle their dollars into our Treasury securities, keeping our interest rates–some would have said–artificially low, but nonetheless low.

Wednesday – we get our first of three looks at inflation, this one on imported inflation.  The Import Price Index will be released and is expected to show that prices rose by 0.4% in April versus -0.5% in March.  This data is heavily weighted toward energy prices.  On a year-over-year basis, import prices have fallen by 14.9%.  Business Inventories are also released and are expected to show a further-compressed spring.  That is, when we truly get green shoots or actual improvement, there will be a stampede to rebuild inventories, and that will kick output in the muffins(Stettner-family word for  ”butt.”)

Thursday – the Producer Price Index is released.  Economists expect the headline results to show nearly flat (+0.1%) wholesale level prices in April.  If so, that will mark a sharp improvement from March’s -1.2% decline.  Core prices are expected to be unchanged, as they were in March.  On a year-over-year basis, prices at the headline and core levels have changed by -3.9% and 3.4%.  Initial Jobless Claims are due out at the same time.  As of now, no economist estimates are available.  The numbers to watch are this week’s 601,000 as a comparable and for the revision.  The next lower low is 488,000, which is far enough away that we can just hope for lower highs on the inevitable rebound.

Friday – the consumer level version of Thursday’s inflation report, Consumer Price Index will be released.  Prices in April are expected to have remained flat with0% change at the headline level expected; 0.1% at the core level.  On a year-over-year basis, prices at the headline level are expected to be down by -0.6%; up 1.8% on a core  basis.  The Empire State Manufacturing index is due out, and economists expect it to have stabilized at -14.  Zero marks the demarcation between growth and contraction; -38.3 the low from two months ago.  The year-over-year change in the index is likely to be positive.  Two series that should continue to be ugly are Industrial Production and Capacity Utilization.  Economists look for a decline of -0.5% in the former, a drop from 69.3% to 68.9% in the latter.

If you’re fortunate enough to be able to, give your Mom a kiss this weekend.

Best regards,

Graig Stettner, CFA, CMT

Investment Management Services

Tower Private Advisors

 This e-mail, its cynical style, ignorance of punctuation convention, and a host of other aspects, assuredly do not represent the views of Tower Bank or Tower Private Advisors. In fact, there are folks here who likely cringe upon receipt of it. If anything you have read here has offended your sensibilities, well, tough. Also, if there are typographical, grammatical, or stylistic errors above, you can see why we don’t teach English Composition. The passive tense, where used, is regretted. If you have suggestions for improvement, keep them to yourself. Just kidding . . . really; send ‘em in.




   Current   Last Week  $ Chg % Chg
Light Crude Oil – Continuous Contract          56.71          53.20 3.51 6.60%
Natural Gas – Continuous Contract            4.08            3.55 0.54 15.09%
Gold – Continuous Contract        915.50        888.20 27.30 3.07%
United States Dollar Index          82.58          84.71 -2.13 -2.51%

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